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A Case for Monetary Policy Accommodation Virginia Commonwealth University School of Business Foundation 2013 Investors Circle Dinner Richmond, VA April 2, 2013 Charles L. Evans President and CEO Federal Reserve Bank of Chicago 1 Long-Run Strategy for Monetary Policy (January 2012) π* = 2% PCE inflation Ut* ~ 5.25% - 6% time-varying SEP long-run central tendency Balanced approach to reducing deviations of inflation and employment from long-run objectives Current and Expected Policy Losses Loss Function (percent) L = (π - π*)2 + 0.25 (y – y*)2 L = (π - 2)2 + (u – un)2 π=5.5% 2014 FOMC Forecast (March 20, 2013) Current Value u=9% September 2011 value Subdued Actual and Expected Inflation Expected Future Three-Year Ahead Inflation Total PCE Price Index (level) 140 (percent) 2.50 Dec. 2007 130 2.25 2% Price-Line from December 2007 120 Expected Inflation for 2023 (as of 2020) 2.00 Path Implied by Current FOMC Inflation Forecasts 110 100 Total PCE 1.75 1.50 Expected Inflation for 2016 (as of 2013) 90 2007 2009 2011 2013 2015 Source: Inflation forecasts are from the March 20, 2013 FOMC Summary of Economic Projections 1.25 2013 2014 2015 2016 2017 2018 2019 2020 2017 Expectation As Of Source: FRB-Chicago Staff Calculations Recent Policy Actions Open-ended Treasury and MBS purchases – $85 billion per month – Until there is substantial improvement in labor markets Low fed funds rate at least until: – Unemployment < 6.5% or – Inflation forecast > 2.5% Highly accommodative policy even after the recovery strengthens Alternative Policy Prescriptions Federal Funds Rate (percent) 6 Taylor Rules: Rt = 2.0 + πt + 0.5(πt – 2) + α gapt Taylor 1999: α = 1.0 Taylor 1993: α = 0.5 5 4 Optimal Control Taylor 1999 Taylor 1993 3 Optimal Control: Min (πt – 2)2 + (ut - un )2 + ΔRt2 2 1 0 2011 2012 2013 2014 2015 2016 Source: Janet L. Yellen, “Perspectives on Monetary Policy,” Boston, June 6, 2012 2017 2018 Progress toward the Dual Mandate Goals with Alternative Policies Unemployment Rate PCE Inflation (percent) (4-quarter percent change) 10.0 3.5 9.0 Optimal Control Taylor 1999 Taylor 1993 8.0 2.5 7.0 FOMC Threshold Peak: 2.3% 2.0 2017Q1 FOMC Threshold 2015Q1 6.0 3.0 2016Q1 5.0 1.5 1.0 4.0 Optimal Control Taylor 1999 Taylor 1993 0.5 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018 Source: Janet L. Yellen, “Perspectives on Monetary Policy,” Boston, June 6, 2012
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